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Pathfinders: The 2015 SMA Managers of the Year

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It’s not easy to “beat the market” when it comes to investing on behalf of your clients, but it’s even more difficult to do so consistently, year after year, by following rigorous research-based quantitative processes that also employ the qualitative intellectual capital skills of an independent-minded firm’s experienced portfolio managers and researchers.

Moreover, simply beating the market may not be the goal of specific clients: Preservation of capital for retired clients may be a higher goal, as may employing a tax-efficient strategy. Finally, it can be difficult or costly to gain access to the best managers, assuming you can identify them among the thousands of mutual funds, ETFs and private investing vehicles that exist.

Those are the reasons that for 11 years Investment Advisor has partnered with the due diligence experts at Envestnet | PMC to identify the Separately Managed Account Managers of the Year whom advisors can use on behalf of their clients. The 2015 SMA Managers of the Year were announced in May at the Envestnet Advisor Summit, following a well-honed months-long process that began with Envestnet | PMC’s analysts working their due diligence magic on the universe of SMA strategies and concluded with an awards committee comprising Tim Clift and Geoff Selzer of Envestnet and IA editor Jamie Green making the final decision.

A striking example of this year’s honorees is the overall manager of the year—a first-among-equals award chosen from the individual winners—Cushing Asset Management for its Cushing MLP Core strategy, which invests in the entire energy supply chain. Led by Libby Toudouze, who graces our cover, the energy MLP portfolio won Specialty Manager Award for the second straight year.

As you recall, 2014 was a challenging year for energy investing, to put it mildly. The Envestnet | PMC analysts lauded Toudouze and her portfolio team at Swank Capital, general partner for Cushing, for outperforming its peers in a good year for energy investing (2013), but more importantly in the challenging 2014. Two data points tell you much of what you want—and need—to know about the Cushing strategy (and any good manager’s strategy, for that matter). From Jan. 1, 2012, through Dec. 31, 2014, the MLP Core strategy’s capture ratio was 150% on the upside and 65% on the downside, as measured against the Alerian MLP Index (AMZX).

In the pages that follow, and in video interviews on, we’ll tell you more about this elite group, their processes, and their people and culture.

A webinar on June 9 (archived on featured the winners of our two newest categories: Impact Award winner Duane Roberts representing Dana Investment Advisors for its Socially Responsible Equity strategy and Strategist Award winner Geremy Van Arkel for Frontier Asset Management. Unbidden, Roberts and Van Arkel repeatedly uttered the words “consistent” and “independent” throughout the session in describing their investing processes and their corporate cultures—which should be sweet music to the ears of advisors everywhere.

Continue reading to find out who else won awards for the 2015 SMA Managers of the Year, and follow the link to find all of our coverage on this year’s awards.

Specialty and Overall SMA Manager of the Year

Libby Toudouze, Partner and Portfolio Manager MLP Core, Cushing Asset ManagementCushing Asset Management won last year’s SMA Specialty Manager of the Year award for its long-only MLP Alpha Total Return strategy. We quoted Swank Capital President and portfolio manager Libby Toudouze as saying that “there are winners and losers in the MLP space, and they are not cheap.” However, she said then that “the potential for returns is certainly there,” with the key to maximizing returns consisting of “going with a manager who has been in this space and dedicates the time and the resources to do the necessary research.”

That’s certainly the case with Cushing, and is reflected in it being awarded the SMA Specialty Manager of the Year in 2015, this time for its MLP Core strategy, and the overall SMA Manager of the Year for its nimble performance during the soaring and then tumbling fortunes of energy investments in 2014, especially in the MLP space.

If it’s true that, as Dr. Martin Luther King Jr. said, “The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy,” then Toudouze and her team at Cushing can stand tall. As we said in presenting the award to Toudouze at the Envestnet Advisor Summit in May, 2014 proved to be a tumultuous year, when energy prices were volatile and alpha was difficult to find, particularly in the MLP space.

In 2014, the SMA returned 22.37%, far outpacing its benchmark, the Alerian MLP Index, which was up 4.8% for the year. That’s nothing new for the Core strategy portfolio, which has outperformed the index in each calendar year since its 2010 inception. In the fourth quarter of 2014, a dire one for energy investing, especially MLPs, the Cushing Core SMA saw a decline of 6.24%, compared to the Alerian index’s -12.29% return.

However, as the Envestnet | PMC analysts argued in proposing the Cushing MLP as a candidate this year, “it isn’t performance that drives our positive opinion on this portfolio,” but rather “Cushing’s innovative culture, highly experienced investment management team, deep research capabilities, consistent management approach and keen focus on risk control.”

In accepting the SMA Manager of the Year award, Toudouze made sure to first thank her “phenomenal” team, especially co-portfolio manager John Musgrave. Cushing also has an oversight committee that includes Jerry Swank, who founded Cushing in 2003. Toudouze has 29 years of investment management experience and knows the issues advisors face, since she ran a family office before joining Swank Capital.

The goal of Cushing Core is to outperform the Alerian MLP Index but with less risk by identifying energy MLPs that can grow their cash distributions rapidly. The portfolio construction process blends a bottom-up fundamental analysis of energy infrastructure companies with a top-down analysis of the energy industry, but with a unique risk approach. The objective is to find companies trading at a compelling valuation or at a level that has not priced in all the holding’s identified positive attributes.

In an interview, Toudouze characterized the Cushing Core process as “60% fundamental, thematic,” with the balance being portfolio construction, “which is what really helps you in volatile markets to preserve capital.” She credited the strategy’s outperformance in 2014′s fourth quarter to the “rigorous risk metrics we use in portfolio construction.”

Cushing’s risk controls include using the services of a dedicated risk manager who looks at both company-specific and portfolio risks, like liquidity and concentration risk and the impact of macro events on sub-sectors and individual MLPs and portfolio correlations. The strategy normally has 25 to 30 names in its portfolio and never more than 7% in an individual holding; as of year-end 2014, it had 26 holdings in the portfolio. In addition to a risk manager, the investment team includes a CPA, reflecting the importance of capital allocation and heavy capital use among energy MLPs.

“We have such a big investment team—19 people and nine portfolio managers for a relatively small universe of 150 energy infrastructure companies that trade on the public markets,” Toudouze said. That big team looks at that small pool of candidates, she said, “because we want to have a choice, a large choice, to select from as portfolio candidates.” In addition, Cushing “won’t take big position sizes; we want to identify 25 to 30 companies” that will deliver the performance the firm is looking for. So Cushing looks at an underlying stock’s liquidity—“if a company looks strong from a fundamental perspective but we can’t get in and out of it cleanly, we may not use it as a position” at all or take a smaller position, she said. Finally, “we look at cash flow variability at the underlying company” because “in volatile markets, stocks with high cash-flow volatility won’t fare as well.”—James J. Green

Strategist SMA Manager of the Year

Gary Miller, Founding Principal Frontier Asset Management

In presenting the first-ever Strategist SMA Manager of the Year award to Gary Miller of Frontier Asset Management, Tim Clift of Envestnet | PMC stressed that Frontier has “one of the longest performance track records in the third-party strategist space, dating back to 1999.” But we don’t make the award for longevity’s sake. Instead, we’re honoring Frontier for its cutting-edge set of “globally diversified, multi-asset, risk-based portfolios” and its “subset of unique multi-alternative portfolios.” Moreover, Clift said that “in a period where it’s been difficult for active managers to outperform, Frontier has been able to provide outperformance from both their active asset allocation decisions as well as their manager selection.”

Miller, founder of Sheridan, Wyoming-based Frontier (with outposts in Denver and Atlanta), calls the firm “very academically based” and only half jokes that when he got out of graduate school, he thought investment managers “actually studied Modern Portfolio Theory. It turns out they didn’t.” In looking at the “brilliant” work of Bill Sharpe and Harry Markowitz, though, Miller (an engineer and CFA) said that many investment managers were “misusing the inputs” by “looking backward at historical information that would mislead them about what was going to happen in the future.” At Frontier, “our process starts with Markowitz’s MPT model, but we work very hard at better inputs.”

In recommending it as a candidate for the premiere Strategist award, the analysts at Envestnet | PMC lauded Frontier for its “unique and diversified product offering” of five global diversified asset allocation portfolios and four specialty strategies. The analysts cited the long tenure of its investment team, all of whom have “sizable investments in Frontier portfolios,” which helps align the team’s “interests and actions along with their clients,” and “strong, attractive long-term performance driven by both active asset allocation and manager selection.”

On performance, is Miller worried about continuing to outperform? “It’s tough right now,” he admitted. “We know fixed income yields are low; equity prices are pretty high, so it’s hard to find returns.” However, mere performance is not the goal, he said. “We try to get the best return we can” for what he calls Frontier’s “downside constraints.”

On risk, “we use drawdown numbers rather than volatility. Our balanced portfolio doesn’t have a standard deviation of 10, but is designed so that there’s only a one in 20 chance that a portfolio will lose more than 10% in a year.” That approach—measuring risk by the possibility of major drawdowns in a specific portfolio—“fits in more with how clients” and advisors measure risk. It also allows Frontier “to build portfolios that vary equity exposure over time. When stocks are low, their future returns are higher, all else being equal, so you can own more of them. When stock prices are high, like they are now, there’s a bigger chance of going through” that drawdown threshold, “unless we reduce our equity exposure a little bit. That’s how we design our asset allocation mix: because return expectations change.” Frontier’s multiple portfolios all have “different annual drawdown numbers.”

Don’t let Miller’s folksy humor—“We’re like weathermen: We don’t make the weather, we observe it,” or “We’re headquartered in Sheridan, Wyoming, so we’re a close-knit group; we make up half the town’s population (okay, not quite)”—deceive you on Frontier’s academic credentials or seriousness of purpose. All four members of Frontier’s investment committee are CFAs, but there’s diversification there as in its portfolios: “We all have different attributes, different personalities. My job is process; we don’t make economic forecasts at all. My job is just figuring out ways to improve the process.”

Then there’s Frontier’s trademark “complementary genius” approach that it uses in picking managers. “We use mutual funds to implement our asset allocation mixes,” Miller explained. “So when we come up with an asset allocation mix, we go through the same process every month. We design what we think is the best portfolio for the next 10 years every month. It doesn’t change much every month, but we also know it’s not the best mix—nobody has the best pie chart.” So instead the Frontier process culminates in picking mutual fund managers that “we like, which can add value, so as a group they look like” our target asset allocation mix.—JG

Impact SMA Manager of the Year

Duane Roberts, Director of Equities and Portfolio Manager, Socially Responsible Equity Strategy, Dana Investment Advisors

“Impact” investing, also known by the monikers “socially responsible investing” or “environmental, social and governance investing,” has become particularly popular over the last few years, and multiple studies show that younger, millennial-type investors and female investors prefer to invest their dollars with companies that match their strongly held social, religious or environmental views. But impact investing is old hat for Duane Roberts of Dana Investment Advisors, having created and run such a strategy—quite successfully, thank you—since Jan. 31, 2000. The Dana Socially Responsible Equity strategy was the consensus pick of the SMA Managers of the Year awards committee for the inaugural Impact SMA Manager of the Year, a new award that was encouraged and supported by Envestnet’s partner, Veris Wealth Partners, in building an Impact Investing Solutions program. The award was presented to Roberts in May at the Envestnet Advisor Summit.

The big argument against SRI strategies is that an investor must sacrifice return to match the strict screens that such portfolios use, but the experience of the Dana portfolio belies that notion.

“Our track record shows you don’t have to sacrifice” returns for socially responsible investing, said Roberts, a CFA, senior vice president and director of equities for 35-year-old Brookfield, Wisconsin-based Dana Investment Advisors. “Our social strategy has outperformed our large-cap equity” SMA portfolio, which won SMA Manager of the Year honors in 2014, Roberts pointed out. Yes, “we have more flexibility on market cap,” Roberts admitted, but “even after you factor that out in terms of attribution, there’s still” outperformance in the Dana SRE portfolio.

Dana’s equity investing strategy sounds simple enough: attaining better returns with less risk for clients by finding high-quality but undervalued companies that, in the words of Envestnet | PMC’s analysts, “possess attractive future growth prospects.” The firm-wide process uses top-down quantitative models to analyze a large universe of stocks—in the SRE portfolio’s case, that’s 3,000 U.S. stocks. The firm process ranks the universe, eventually creating a “Dana rank,” by relative valuation and earnings revision/surprise trends. Furthermore, pointed out the analysts, “thematic and demographic considerations also play a limited role in the stock selection process, as they [Dana] firmly believe it is smarter to invest in companies that have long-term trends working in their favor, rather than against them.”

Using that quantitative process “can take some of the fear and greed out of the process” of securities selection, but Roberts said Dana uses fundamental analysis “to confirm and extend” the quant findings.

“We think there are some reasons that historical relationships persist, even if they change. We evaluate and adjust our model to those changes,” said Roberts, but there are also “weaknesses to the quantitative approach, so the Graham-Dodd fundamental approach also has merit.” After all, he said, “sometimes quantitative models miss some obvious things,” mentioning the Deepwater Horizon accident five years ago in the Gulf of Mexico. At that time, said Roberts, “any companies involved in Gulf drilling looked attractive, but there was a good reason why” their stock prices were so low. So the “traditional fundamental work picks up information that isn’t easily quantified,” Roberts said. “Investing is not a pure science yet, so on the fundamental side there’s art.” It’s “the balance of those two approaches that gives us the best of both worlds.”

In building the SRE portfolio, Dana uses data from multiple third-party research services and makes automatic exclusions across the board—adult entertainment (aka, pornography); alcohol; gambling; military and weapons; and tobacco. There are specific screens as well in the environmental (climate change, nuclear power), social (workplace diversity, human rights) and governance areas (board composition, audit and accounting). However, Dana calls its screening process “holistic,” which allows its portfolio managers to “emphasize companies that consistently score well across multiple screens” rather than reward companies that only “excel in one area.”—JG

U.S. Equity Large-Cap

Jeff Moser, Co-Founder, Chief Operating Officer and Portfolio Manager, Large-Cap Core, Golden Capital Management

Golden Capital Management‘s Large-Cap Core is the first of two SMA Managers of the Year for U.S. Large-Cap Equity strategies. Jeff Moser, the company’s co-founder and chief operating officer, created the strategy and manages the portfolio, which is restricted to 50 stocks.

“We believe there is both an art and science so we developed an active quant approach that combines both quantitative analysis and qualitative analysis,” said Moser, who has been managing the portfolio for 20 years.

Golden Capital starts with a broad universe of approximately 1,200 stocks, each with a market capitalization greater than $2 billion, then applies a proprietary quantitative composite model based on valuation, earnings and trading momentum to identify undervalued companies with the potential to deliver better than expected future earnings.

“With a market that is fairly valued to overvalued, earnings matter all the more,” said Moser. “We want companies that have a higher probability of reporting positive earnings surprises, and we choose those based on attractive valuations.”

Then the qualitative work begins, which “allows the team to build a deeper understanding of those ideas that emerge from our quantitative research and ultimately either validates or disproves the findings of our quantitative screens,” said Moser.

For example, said Moser, “If, say, profits are improving, I want to know why and how sustainable that is.” He also wants to know what’s going on with the company’s management team and products, and the industry they’re competing in.

This “best valuation for the best earnings” strategy has served Golden Capital’s Large-Cap Core strategy well. The portfolio has outperformed the benchmark S&P 500 Index for one, three, five, seven and 10 years with a beta of 90.

Since 2007, the stocks in the portfolio have beaten earnings expectations 83% of the time, compared to 72% for the stocks in the S&P 500.

The portfolio has outperformed the S&P 500 for the last three years, following a moderate underperformance in the previous three. Last year, it beat the S&P 500 by 2%, and in 2013, it outperformed by a whopping 8%.

Golden Capital Management’s Large-Cap Core portfolio consists of 50 stocks, representing the 10 sector weightings in the S&P 500, give or take 5%, and Moser maintains a buy list that he can choose from in the future. The buy list serves another purpose as well.

“The composition of my buy list typically changes over time and tends to be a pretty good early indicator of future opportunities in the market,” said Moser. The 100 companies on that buy list helps him decide which sectors to overweight and which ones to underweight.

As of April, the portfolio was overweight health care, consumer discretionary stocks and, to a lesser extent, technology. “That’s where we are finding the [best] earnings,” said Moser. The portfolio is underweight utilities and consumer staples. “The earnings results and valuations are not there,” he said.

Generally, Moser favors companies with strong organic sales growth, new products, increasing margins and rising market share. “We want companies with improving fundamentals.”

Moser also wants to continue improving the portfolio. To that end he runs the firm’s proprietary model every night and continues to seek new ways to enhance it. “I love uncovering new ideas for the portfolio and conducting research that adds further precision to the investing process,” he said.

So does the rest of his investing team, which includes co-manager John Campbell, and several others who average 19 to 20 years of investment experience and have “unique backgrounds in math, computer science or engineering that lends itself to quantitative analysis,” said Moser. “Collectively, we have a shared interest in discovering and better understanding those factors that lead to different price moves in stocks.”

What stands out when talking with Moser is the disciplined approach that he and his team use to develop and maintain the portfolio. Also, unlike some other SMA firms, Golden Capital Management doesn’t automatically rebalance its equally weighted portfolio of 50 stocks if a position climbs above its model 2% weighting. Once a stock’s position climbs to between 3% and 3.5%, it will be trimmed back, said Moser. Turnover averages 50% to 70% annually.

The history of Golden Capital Management is also unusual. After Moser started the firm with Greg Golden, its president and CEO, and was joined several months later by John Cangalosi, the firm became part of the California Public Employees Retirement System (CalPERS) Manager Development Program, investing on behalf of the giant pension fund. CalPERS took an equity stake. Several years later, Wachovia became a minority owner, replacing CalPERS, and in 2011, GCM acquired the Global Strategic Products business from Wells Capital Management, a subsidiary of Wells Fargo, which had previously acquired Wachovia. In exchange, Wells Fargo got an additional ownership stake in the firm and now owns 65%. The remaining ownership is held by GCM partners Moser, Golden and Cangalosi, but Wells Fargo has the option to purchase half their stake beginning January 2016 and the remaining half beginning January 2017. Envestnet | PMC’s analysts say they “don’t have any major concerns” at this point in time, but it will be “closely monitoring the potential ownership changes in 2016 and 2017.”—Bernice Napach

U.S. Equity Large-Cap

Richard Alpert, Managing Partner and Portfolio Manager, Dividend Growth, Raub Brock Capital Management

Raub Brock Capital Management’s Dividend Growth portfolio is the second SMA Manager of the Year in the equity large-cap category.

The $600 million-plus strategy led by Managing Partner and portfolio manager Richard Alpert targets high-quality stocks with annual dividend increases of 10% or greater for at least five years to generate returns with less risk. That’s almost twice the 5.7% annual dividend increase of the S&P 500 over the past 50 years.

The dividend yield must be greater than 1% at the time of stock purchase—“that assures that companies are committed to sharing their profits with shareholders,” said Alpert—and the market capitalization must be at least $2 billion to insure sufficient liquidity in the stock’s market trading.

“Our focus on dividend growth makes us different,” said Alpert. “Many growth fund managers do not have an interest in dividends.”

Dividends aren’t the only criteria the portfolio uses in its bottom-up approach to stock selection. Increasing revenues, earnings and net income are also key.

“We want dividends to be paid out of current revenues and earnings, [which] speaks to the quality of the earnings,” said Alpert.

The strategy tends to avoid companies that use debt to finance buybacks—an example of “financial engineering” that is “not geared to the long-term success of a company,” said Raub Brock analyst Jason Rodnick.

Another distinction of Raub Brock’s Dividend Growth strategy: its very concentrated portfolio of 20 stocks that are equally weighted.

“We think that good stock selection can have a meaningful impact on performance,” said Alpert.

But how do you choose 20 stocks out of a universe of thousands? With quantitative and qualitative analysis, in that order, according to Alpert.

“We take a universe that starts out with about 4,000 companies and we narrow it down to 250 based on that initial screen,” said Alpert, referring to the 10% annual dividend growth, 1% minimum current dividend yield and $2 billion minimum market cap. Then the screening turns qualitative, looking at fundamentals for growth, quality, valuation and volatility over time.

These include historical growth in dividends, revenues, earnings and net income; the strength of balance sheets, return on equity and credit ratings; and the ratios of enterprise value (market cap plus net debt) over EBITDA (earnings before interest, taxes, depreciation and amortization) plus P/E over the dividend growth rate. “Basically we look at whether we’re getting companies that are growing their dividends at fair value,” said Alpert.

Finally, Raub Brock’s Dividend Growth strategy looks at volatility over time, preferring those stocks whose price movements don’t stray far from expectations. “We think a lower volatility portfolio generates better returns,” said Alpert.

Executing this disciplined approach to stock selection has clearly paid off for Raub Brock’s Dividend Growth strategy. The portfolio earned 14.4% in 2014, 1.3% more than the Russell 1000 Growth Index, and it has outperformed that benchmark for the past one, five, seven and 10 years ended Dec. 31, 2014, while taking on a lot less risk. (It underperformed slightly for the three-year period).

The strategy’s beta over the past 15 years is just 0.72 compared to the Russell 1000 Growth Index, and its risk-adjusted returns for the past five, seven and 10 years places it in the top decile of its peers in the SMA large-cap growth universe.

The strategy’s turnover rate is especially low, averaging just 25% a year, and turnover is primarily due to trimming positions in order to maintain equal weighting of stock holdings rather than selling entire positions outright. “We tend to hold companies for three to four years or longer,” said Alpert.

Stocks are replaced if dividend growth declines and Alpert and his team don’t expect it will re-accelerate. The portfolio has “never” held a stock whose dividend was cut, said Alpert.

As of April 2015, the portfolio’s top 10 holdings included three health care companies, two consumer staples, three consumer discretionary stocks, one energy master limited partnership and one financial research company. The dividend yield ranged between 1.1% and 3.6%, and averaged 1.67%.

“Our success is attributable to our unwavering adherence to our discipline and framework,” said Alpert, who heads a three-man team that, in addition to Rodnick, includes David Raub, the founder of the 100% employee-owned firm and its research director.—BN

U.S. Equity Small- or Mid-Cap

David Dalrymple, Senior Portfolio Manager and Managing Partner, Small-Cap Value, Chartwell Investment Partners

Valuation opportunities constitute the core holdings of Chartwell Investment Partners’ Small-Cap Value strategy, this year’s first SMA winner in the Small-Cap and Mid-Cap U.S. Equity category.

“When a company is selling at a valuation less expensive relative to the market than it has in recent years, that’s a good indicator of an opportunity for us,” said David Dalrymple, the senior portfolio manager of the $1 billion portfolio and managing partner of Chartwell Investment Partners.

Finding those opportunities is an involved process that Dalrymple said is “more art than science.” It starts with a screening for U.S. companies with capitalizations between $100 million and $2.5 billion, looking at valuation ratios such as price-to-earnings, price-to-sales, price-to-book and price-to-cash flow. Eventually those 3,000 to 3,500 names are reduced to a target list of 150 to 200 names that have been screened for liquidity, valuation discounts to the Russell 2000, prices near the low end of their historical ranges, historical returns, margins and business prospects. What’s left are “companies that are inexpensive relative to the market and relative to their history,” said Dalrymple.

This list is further reduced to 65 to 80 candidates with some characteristic that increases their potential for capital appreciation—“something that the market is not understanding or missing in the time frame about a company,” and that “can rectify whatever those short-term problems are,” said Dalrymple. It could be better margins, improved cash flow, debt paydown or something else, but “not just a strike-of-lightning, event-driven catalyst.”

The result is a portfolio of 70 stocks—a “reasonable concentration,” said Dalrymple—that have been carefully chosen through an eventual bottom-up process. “We’ve made our money [from] stock picking, not sector rotation,” he said. Indeed, Envestnet | PMC’s analysts noted that “100% of outperformance” in the portfolio is due to its selection of stocks.

Since January 2007, Chartwell Investment Partners’ Small-Cap Value strategy’s annualized risk-adjusted performance—its alpha—has averaged 3.9% above that of the Russell 2000 Value Index.

The portfolio is currently concentrated in financials, REITs and utilities—interest-rate-sensitive sectors—which make up about 45% of the portfolio. “We’ve bulked up our bank weight because loan growth is beginning to pick up,” said Dalrymple, adding that these stocks are generally smaller, regional banks from all around the country.

Other major allocations include industrials and some consumer stocks. There is little exposure to health care and technology, which a “small-cap growth benchmark would have,” said Dalrymple.

The portfolio has been adding more business services stocks that “have low capital requirements, offer unique services to other businesses and have good growth prospects and valuation,” Dalrymple said.

And it’s been reducing exposure to consumer companies such as retailers that Dalrymple said have already “benefited from lower gas prices and more money in consumers’ pockets.” It’s also cut back on transportation companies, which are near the “peak of their cycle for volume and pricing.”

Despite these changes, Chartwell Investment Partners’ Small-Cap Value strategy “is only about 12% or 15% different now from where it was at the start of the year,” said Dalrymple, which is in keeping with its annual turnover of about 30%.

Dalrymple, who has managed the strategy since its inception in 1999, is the lead decision maker on all these changes and the portfolio overall, but he has a team of generalists to help with the extensive analysis to identify potential targets and monitor the portfolio.

“We want generalists as analysts because we think that’s the best way for all to understand what makes a good investment idea,” said Dalrymple. “It helps us be informed enough so that we can question each other and challenge each other on ideas that we bring in our discussions.”

Dalrymple said his analysts “have focused very well on picking stocks [and] seeing opportunities,” but the Envestnet | PMC analysts reported that “the team’s edge is the expertise and experience of the lead portfolio manager David Dalrymple. […] We believe Mr. Dalrymple’s experience in managing portfolios over multiple cycles is a key benefit to investors in the portfolio, and like the fact that 100% of outperformance since he has been at the helm has been through security selection.”—BN

U.S. Equity Small- or Mid-Cap

Todd Solomon, Portfolio Manager, Mid-Cap Growth, Congress Asset Management

Congress Asset Management, winner of the Mid-Cap U.S. equity portfolio award, makes money the old-fashioned way. It uses fundamental analysis to find the 40 stocks that the portfolio holds in equal weights. “We don’t need a screen to come up with names,” said Todd Solomon, who chairs the firm’s Mid-Cap Investment Policy Committee and leads the portfolio. “The committee has over 100 years of investment experience. We know the space pretty well.”

The firm’s Mid-Cap Growth portfolio differentiates itself in other ways as well. While many SMA and mutual fund equity managers strive for growth at a reasonable price, Congress looks for growth at a reasonable risk. “We’ve always been focused on preservation of capital, maintaining the assets of our clients and protecting on the downside,” said Solomon. “Since day one, that’s always been a focus of our firm, and it’s always been the focus of this product.”

Congress Asset Management also measures risks somewhat differently from other asset managers. In addition to the quantitative measure of volatility that looks at beta or standard deviation—the portfolio has a beta of 68, compared to the Russell Mid-Cap Growth Index and a standard deviation of 19.77 versus 25.98 for the index—on a day-to-day basis, Solomon said the risk is that a client will call asking “why they lost money in a particular investment and why they could potentially no longer meet their goals because of decisions we have made for them.”

The portfolio manages risk in several ways, primarily through diversification. No single stock can account for more than 5% of assets; individual industries are capped at 15% of the portfolio; and sectors—which include several industries—are limited to 25%.

“We don’t want to have too many names in the portfolio that will suffer if they have similar drivers,” said Solomon. “We want to make sure we maintain consistency across industries and sectors just as well as across economic drivers so that we don’t have a malaise fall over a large part of our portfolio at the same time.”

When a stock in the portfolio appreciates much faster than others, reducing diversification, that position will be trimmed back to 2% to 2.25% and the proceeds will be reinvested in other positions that haven’t gained as much, said Solomon.

“We focus on what could be wrong with the portfolio,” he said.

Perhaps that’s why so much has gone right with it. Since its start in the fourth quarter of 1999, the portfolio has gained a gross 13.08% return on an annualized basis—more than twice the 5.86% return for the Russell Mid-Cap Growth Index.

The portfolio invests in high-quality mid-cap companies with consistently increasing earnings, revenues and free cash flow that are priced at reasonable valuations compared to historic levels. It favors companies with increasing margins and unique business models in a growing industry.

“We come up with a thesis and reason for owning the stock,” said Solomon. “As long as the company makes progress on that, we will continue to own it.” The “we” Solomon talks about is a small team that includes two other portfolio managers, including the former lead manager, and one research analyst.

The portfolio tends to hold positions for two to four years. It has a “strict” limit of $20 billion market cap and will sell a stock whose capitalization tops that.

“We want to make sure we are a true mid-cap product so that we don’t overlap with another manager in the [client's] portfolio that may be a large-cap manager,” said Solomon. “We’re usually not the only manager that’s been put together by an advisor for the solution for a client. We want to make sure we live up to our part of the bargain.” They also want to make sure they deliver clients a “SWAN” portfolio—one that lets them “Sleep Well At Night.”

“Consistency is important because if you think of the time period since [the portfolio started], investors who have been in the benchmark have lost half their money twice. […] It allows us to be extremely consistent across investment decisions and across investment markets.”—BN

International or Global Equity

Kera Van Valen, Managing Director, Portfolio Manager and Senior Research Analyst, Global Equity Shareholder Yield, Epoch Investment Partners

Tim Clift, chief investment strategist of Envestnet | PMC and a member of the SMA Managers of the Year Awards Committee, likes to say that when it comes to making a final decision on the awards, “it generally boils down to trying to evaluate an alpha thesis: What differentiates them from other managers in the universe? What’s unique and sustainable? What’s their edge over other managers? What can they replicate going forward?” And finally, “Where are the returns coming from?”

In the case of Epoch Investments Partners, Envestnet | PMC’s analysts noted that its Global Equity Shareholder Yield ADR portfolio has generated 2.7% in alpha since the strategy’s inception in 2006, and 6.3% in alpha since the SMA version of the strategy was launched in 2006, though the analysts also noted it “did have a tailwind with its high-dividend focus.”

In presenting the award during the Envestnet Advisor Summit in May, Clift said the strategy deserved the award “given their strong alpha generation since inception, strong performance in 2014, repeatable investment process and high pedigree investment team, which includes the architect of the strategy and former CEO of Credit Suisse Asset Management Americas, Bill Priest.”

What is the Global Equity alpha thesis? The Envestnet | PMC analysts said it is that a dislocation exists between a stock’s (or in this case, an ADR’s) market price and its long-term intrinsic value due to “most investors’ focus on short-term earnings rather than long-term cash flow generation for equity holders via dividends.” That’s a fine but not terribly unique thesis; what is unique is the execution of the strategy originally devised by Priest who, with Mike Welhoelter, Epoch’s head of quantitative research, built an institutional global portfolio focused on providing “a strong yield for clients by investing in safe and financially stable companies,” the analysts wrote.

In an interview, Managing Director and portfolio manager Kera Van Valen said the Global Equity portfolio is focused on high-quality companies that generate sustainable free cash flow and “return that cash to shareholders through a combination of dividends, repurchases and debt reduction; that’s what we call Shareholder Yield.”

The Epoch team also does fundamental research—“meeting with management, building out models looking back three to five years and looking forward two to three years”—to ensure that Epoch “really understands the capital allocation policies of the individual companies” in the portfolio. “All our research is about understanding the free cash flow drivers” of its portfolio companies and prospective names in the portfolio, but also how the company “will continue to generate cash in the future.”

The Envestnet | PMC analysts wrote that Epoch has been successful in creating a portfolio whose companies have a “history of strong dividend growth […] especially during the financial crisis.”

In the firm’s portfolio construction, Van Valen said “we want to diversify across sectors and countries, but also diversify across our aspirational return of 9%: 4.5% from dividends; 1.5% from share buybacks and debt reduction; and 3% from growth.” That diversification, across both income and growth, serves to minimize risk in the portfolio, “No more than 3% of our dividend can come from any one name in the portfolio. If something happens to that dividend, it doesn’t put our aspirational dividend at risk.”

The process yields, she said, a portfolio of “90 to 120 names in which we have very high conviction of the company’s ability to sustain and grow the dividend in the future.” While it’s “important that they have attractive cash flows now,” Epoch wants to see that those companies are also “investing in the business so we can hold them for the long term.”—JG

Fixed Income

Mary Kane, Partner and Lead Portfolio Manager, Enhanced Core Bond, GW&K

For the second time in three years, GW&K has won the Fixed Income SMA award for its Enhanced Core Bond portfolio, which has “an excellent trade record […] whether measured on an absolute or risk-adjusted basis,” according to Envestnet | PMC. The “enhanced” label comes from its inclusion of high-yield bonds.

In addition to high-yield securities, which are limited to 20% of assets, the portfolio invests in investment-grade bonds (42% of assets at the end of the first quarter), mortgage-backed securities (27%), government agencies, taxable munis and a smattering of Treasuries, and actively rotates sectors depending on valuations based on historical trends.

The portfolio starts with a top-down analysis of the overall business cycle, U.S. economy and monetary policy to decide which bond sectors other than Treasuries—also known as “spread product”—to overweight or underweight and the overall duration. Then a group of four senior credit analysts, each specializing in a particular sector, plus three dedicated traders get to work, looking for mispriced securities and sectors.

A prime example of this is when in late 2008 the team saw that high-yield spreads were 2,000 basis points (20%) over Treasuries. “It was something we had never seen before,” said Kane. “We knew that the Fed was going to come in and lower interest rates and we would get the compression that we were looking for over the next few years.”

And they did, producing profits for the portfolio. The current spread between high-yield bonds rated B- and better is around 450 basis points, which is close to normal, but that spread could tighten further. “In prior recovery periods the spread has gotten as tight as 235 basis points,” said Kane.

“We believe when you buy mispriced sectors or mispriced securities, […] you generate more income, better capital appreciation over time and, over the long run, you deliver better risk-adjusted returns,” she said.

This approach has worked well for GW&K’s Enhanced Core Bond strategy, which consistently ranks in the top decile of intermediate taxable separately managed accounts and has gained roughly half to 10 percentage points more than the Barclays Aggregate Bond Index in five out of the past six years (it tied in 2011).

“We tell clients we want to deliver income and capital appreciation and beat the Barclays Aggregate by 50 basis points,” said Kane. Last year, the portfolio gained 6.4% compared to 5.9% for the Barclays Index, slightly less than the targeted 50 basis points, but most years it outperformed the index by a much wider margin. In 2009, the portfolio gained 16.2%, compared to 5.9% in the index.

“Clients are primarily looking for income, which is so dear these days,” said Kane. “When you hold income over time, you will beat Treasuries.” In addition, said Kane, bonds provide a “hedge against stock market volatility. Bonds zig when everything else is zagging.”

Now, GW&K’s Enhanced Core Bond strategy, like most bond and equity portfolios, is waiting for the Fed to raise interest rates for the first time in nine years, but unlike many managers, who are now moving down the so-called yield curve favoring shorter term securities, GW&K’s Enhanced Core Bond portfolio is underweight the short end of the yield curve, up to five years, and slightly overweight 10-year maturity bonds on the long end. In other words, GW&K is positioned for a flattening of the yield curve—for long-term rates to fall while short-term rates rise as a result of a Fed rate hike.

“I know everyone is really worried about rates going up and the potential for losing money, but if you hang in there with a two-year holding time period, historically, you have never lost money in the bond market even with the Fed raising interest rates,” said Kane. “The corporate sector can do well even when the Fed is raising rates [because that is] signaling the economy is strong,” added Kane. Indeed, U.S. companies now have balance sheets in great shape, record margins and enough revenues to cover their debt payments, according to Kane.

The risk, she said, is only if the Fed moves too soon and too fast, which doesn’t appear to be the case currently.

Fed Chair Janet Yellen, in a speech in late May, said the Fed will likely raise rates this year if she sees “continued improvement in labor market conditions” and is “reasonably confident that inflation will move back to 2% over the medium term.”

In the meantime, the $850 million Enhanced Core Bond portfolio will continue to focus on the bonds of U.S. companies, searching for those mispriced market anomalies. Among investment-grade bonds, the strategy is favoring banking—“more regulation makes sure there’s enough capital on balance sheets,” said Kane—industrials, communications and taxable munis. Among mortgage-backed securities, the portfolio favors higher coupon, premium securities. “You get more predictable cash flows, less extension risk and lower duration at about 2.5 years, [and they] perform well when rates rise,” said Kane.

In high-yield, the favorites are energy and basic industry bonds, and a continued quest for bonds with a story, such as fallen angels that were downgraded but are poised for a comeback, which can take several years.—BN


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